Clearing houses stand in between two counterparties to a trade and collect collateral from each that is used to mitigate the risk of default. Clearing houses are allowed to use the collateral posted by members to make low-risk investments.

The FIA concerns were made in separate letters to Ice Clear Europe last week and LCH.Clearnet last month and relate to how clearing houses invest the collateral posted by their members and allocate any potential losses to members. The FIA has asked both clearing houses to revise their rules.

Changes to the clearing houses’ rulebooks follow new UK laws from the Bank of England that came into force on May 1 that require clearing houses to have plans in place to deal with investment losses.

Under the changes to ICE Clear Europe’s rulebook, the clearing house would set aside $90 million of its own capital to deal with investment losses before allocating any remaining losses among members, while under its changes LCH.Clearnet would contribute €15 million itself before passing losses to members.

Some investment gains made by ICE Clear Europe from the investment of member collateral are passed back to members, while LCH.Clearnet does not currently pass back investment gains.

A letter from LCH.Clearnet dated April 22 detailing the rules changes said collateral is primarily invested in reverse repos and high-quality sovereign debt instruments and that losses allocated to members are weighted in proportion to the collateral posted. The ICE Clear Europe rules state that member contributions to default losses will not exceed the amount of collateral posted.

Related

In both cases, the FIA pointed out that there is no assurance that either clearing house would not reduce the amount of its capital used to absorb losses or change its contribution in line with investment risk. Both letters also call on the clearing houses to provide detailed information on their investments to members.

John Wilson, global head of OTC clearing at broker Newedge, said: "While sympathising with the desire to make clearing houses 'bombproof', asking members to shoulder a wider set of risks than member default means clearing houses are effectively socialising their losses and privatising their profits i.e. the shareholders of the clearing house will keep the net investment returns but if there is a problem, their members could have liability for potentially substantial losses for which they are not compensated."

Paul Swann, president, ICE Clear Europe, said: “We are currently reviewing feedback received from members in relation to recent rules we have put in place to meet new UK legislative requirements for dealing with investment and non-default losses, and we intend to continue a dialogue with them, including any potential further changes."

LCH.Clearnet declined to comment.

G20-led reforms to OTC derivatives markets require market participants to process more of their swaps trades through clearing houses to limit systemic and counterparty risks. The obligation to clear swaps has started in the US and will begin in Europe early next year. The rules have sparked debate on the recovery and resolution plans clearing houses have when facing stressed market conditions.